Merger expense, increased labor costs reduce Alaska Air income

An Alaska Airlines jet is parked on a runway while another takes off at the Seattle-Tacoma International Airport on April 13. After years of record profits, Alaska Airlines' parent company saw net income dip to just $4 million as it absorbs merger expenses related to the acquisition of Virgin America and increased labor costs from new contracts with employees and pilots. (Photo/Ted S. Warren/AP)

Growing costs trimmed Alaska Air Group’s first quarter 2018 net income to $4 million, company executives reported April 23.

The Seattle-based parent company to Alaska Airlines and regional carrier Horizon Air reported $18 million in profits excluding costs related to its 2016 acquisition of Virgin America airlines, a $1,000 per-employee bonus tied to federal tax cuts and fuel hedging accounting adjustments, among others.

For comparison, Alaska Air Group netted $93 million in the first quarter of 2017 and $184 million in the first three months of 2016 — also the last first quarter of operations before it purchased Virgin American in a $4 billion deal that closed in December 2016.

Alaska Air Group CEO Brad Tilden said Alaska Airlines is in the midst of the most important parts of its merger with Virgin America and the company is starting to plan for the time after the airlines are fully blended during a conference call with investors.

The complex merger is “reaching a crescendo tomorrow night (April 24) as we transition to a single passenger service system,” Tilden said in the April 23 call.

“This event will mark our shift to a single brand and customer experience everywhere our guests interact with us,” he said further.

Alaska Air Group has been directing Virgin America bookings to Alaska and performing other operations as a single airline for some time to assure a smooth transition, according to Tilden, which means the remaining passenger service system integration will mostly be limited to what customers see and not integral behind-the-scenes processes.

He emphasized that the company is encouraged about its prospects despite the immediate sharp decline in profitability.

“Our platform, which is 33 percent bigger than it was just 16 months ago and 100 percent bigger than it was five years ago, maintains the same competitive advantages it always has,” Tilden said.

The $4 million profit translates to 3 cents per diluted share. Alaska Air Group paid a first quarter dividend to its shareholders of 32 cents per share. The company’s stock closed trading April 23 at $69.11 per share, up 5.7 percent from its April 20 closing price despite the lukewarm financial results.

First quarter revenue was up 5 percent year-over-year to more than $1.8 billion; however, operating costs were also up 14 percent, which led to an 82 percent drop in operating income to $29 million.

Tilden said company leaders expect the merger to result in $280 million of new revenue in 2019 and that the company plans to grow its capacity by just 4 percent by 2020, choosing instead to leverage the benefits of its previous growth.

“We are absorbing substantially all of the merger-related cost increases this year,” he added.

Chief Financial Officer Brandon Pedersen said the executives are not happy with the first quarter financials and are taking steps to improve the profitability of the company.

“Our near breakeven result came during a time of new merger integration activities, significant new market development, rising fuel prices, new labor agreements and continuing areas of competitive pressure in our network,” Pedersen said during the earnings call.

A new labor agreement with Alaska Airlines flight attendants increased labor costs by $9 million for the quarter and when combined with a pilot contract signed in late 2017 amounted to eat up about two-thirds of the 5 percent revenue growth, according to Pedersen.

Air Group’s wage and benefit costs increased $84 million, or 19 percent, in the first quarter.

Additionally, total fuel costs were also up $93 million, or 29 percent, paralleling increased oil prices.

Despite that, Pedersen said without the new, more fuel-efficient Boeing 737s Alaska continues to receive as it phases out older aircraft, the company’s fuel costs would have been $5 million more. Alaska Airlines’ fuel efficiency improved 1.5 percent year-over-year. He also noted the company has hedges on 47 percent of its expected fuel consumption for the remainder of the year.

Overall, the company expects its full-year unit costs to be up about 3.5 percent.

“In general, I’m seeing examples of great back-to-basics cost management across much of the company,” Pedersen said. “The credit goes not only to our leaders but also to our frontline employees for embracing the need for productivity gains.”

Alaska Air Group recently lowered its expected capital expenditures in 2018 to $1 billion, with further plans to spend about $750 million per year on capital investments in 2019 and 2020. The company also restructured its new aircraft delivery schedule over the next three years to help lower capital costs and increase free cash flow, according to Pedersen. He thanked Boeing and the other airline manufacturers it has purchase agreements with for being amenable to the changes.

Alaska Air Group generated $310 million in operating cash flow during the quarter and spent about $235 million of it on capital expenses, the earnings report states. The company, with $10.8 billion in total assets, held roughly $1.5 billion in cash at the end of the quarter.

“Our balance sheet continues to get stronger with total on-balance sheet debt declining another $120 million since year-end,” Pedersen said.

Company executives have long-stressed their desire to maintain an “investment-grade balance sheet” and with its aircraft leases the company’s debt-to-capitalization ratio held flat 53 percent for the quarter.

Pedersen said the debt-to-cap ratio should drop to 50 percent by the end of the year, while at the same time returning about $200 million to Air Group shareholders through dividends and share buy-backs during 2018.

Tilden also thanked Alaska Airlines employees for moving the merger along “in record time” in his comments during the earnings call.